Lesson 6 of 7
Unlevering and relevering
Strip the debt out of two real betas and one falls from 1.64 to 0.86 while the other holds near 0.22. The businesses still differ after that.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- A measured beta describes the equity of a company carrying a particular debt load, so two companies' betas are not comparable until the leverage is removed.
- Removing it from two real companies took one from 1.64 to 0.86 and left the other near 0.22, a business difference the raw figures overstated.
- Putting the same capital structure on both still leaves them far apart, which is the answer the adjustment exists to produce.
Beta is measured on a share price, and a share price belongs to the residual claim after the debt. More debt makes the same business riskier for its shareholders, so the measured beta rises with leverage even when nothing about the business has moved.
Unlever, compare, relever
- Take the measured beta and the capital structure. Carnival's two-year weekly beta is 1.64, with debt at 47.45 percent and equity at 52.55 percent of capital. Procter and Gamble's is 0.239, with debt at 8.97 percent.
- Take each company's own effective tax rate. Carnival's filed rate is 0.43 percent; Procter and Gamble's is 20.77 percent.
- Unlever. Divide the levered beta by one plus the after-tax debt to equity ratio. Carnival: 1.64 divided by 1.899 is 0.864. Procter and Gamble: 0.239 divided by 1.078 is 0.222.
- Compare. The raw betas differ by a factor of 6.9. The unlevered ones differ by a factor of 3.9. Financing explained part of the gap and the business explains the rest.
- Relever at the structure you are pricing. Put Carnival's capital structure on Procter and Gamble's business and its beta becomes 0.380, a cost of equity of 7.09 percent. Put Procter and Gamble's structure on Carnival's business and its beta becomes 0.948, a cost of equity of 10.22 percent.
Two companies, before and after the leverage is removed
- Carnival, as measured1.640x
- Carnival, unlevered0.864x
- Procter and Gamble, as measured0.239x
- Procter and Gamble, unlevered0.222x
Why the two adjustments differ so much
The size of the adjustment depends on two things: how much debt there is, and how much the tax shield is worth.
Carnival's debt is 90 percent of its equity at market value, so the correction is large. Procter and Gamble's is 10 percent, so it is small. And Carnival's effective tax rate of 0.43 percent means the shield barely dampens the effect, where a 21 percent rate would have softened it.
A practitioner who unlevers with a statutory rate for both companies gets the wrong answer for the one whose income is largely untaxed, which is the case for a great many shipping and cruise operators.
What the adjustment is for
Three uses, and only three.
Comparing companies. Two competitors financed differently have incomparable raw betas. Unlevered, they can be averaged into a business beta for the industry.
Pricing a company you are changing. A valuation that assumes a different capital structure has to use a beta relevered to it, not the one the market measured on the old structure.
Valuing a private or newly listed business. With no price history there is no measured beta, so the standard route is to take listed peers, unlever them, average, and relever at the target's own structure.
What it does not fix
The adjustment assumes the debt itself carries no market risk, which stops being true for a heavily indebted company whose bonds trade like equity. It assumes the tax shield has the same risk as the business. And it inherits every weakness of the input: an unlevered beta built on a beta measured over the wrong window is a tidier version of the same error.
Check yourself
Why do two competitors' measured betas need unlevering before they are compared?
- Because betas are measured over different windows
- Because a measured beta describes the equity of whatever debt load the company carried, so financing is inside the number
- Because one may be larger than the other
Show the answer
Answer: B.
More debt raises the risk borne by shareholders without changing the business. Stripping it out leaves the part that is about the business.Carnival's effective tax rate is 0.43 percent. What does that do to the unlevering adjustment?
- Nothing, the tax rate is not part of it
- It makes the correction larger, because almost no tax shield offsets the effect of the debt
- It makes the correction smaller
Show the answer
Answer: B.
The adjustment divides by one plus the after-tax debt to equity ratio. With almost no tax, the full debt to equity ratio applies.When is relevering the necessary step?
- Whenever a beta has been unlevered
- When the valuation assumes a capital structure different from the one the beta was measured on
- Only for private companies
Show the answer
Answer: B.
An unlevered beta prices an unlevered business. Any valuation of an equity claim has to put the intended capital structure back on.Sources
- The product's own stored betas and capital weights for the two companies, measured over two years of weekly returns against SPY to 2026-09-15.
- Carnival Corporation and plc, Form 10-K, fiscal year ended 30 November 2025, filed 2026-01-27; Procter and Gamble, Form 10-K, fiscal year ended 30 June 2026, filed 2026-08-04: income tax expense and pre-tax income behind each effective rate.
- Modigliani and Miller, 1958: capital structure irrelevance under their assumptions, and the cost of equity rising with leverage.
What this leaves out
- The standard adjustment assumes the debt bears no market risk of its own, which fails for a heavily indebted company whose bonds trade like equity.
- Debt and equity weights here are the product's own: equity at market value, debt at the latest filed book figure.
- A single year's effective tax rate is a weak estimate of the shield on future interest, and both figures here are one year.
- Nothing here is advice about any security.